16 June 2020 Internal T.I. 2019-0792651I7 - 10(8) of the Canada-UK Tax Treaty

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: 1) Does 10(8) only apply in circumstances of “treaty shopping” and 2) if not, does it apply to deny all the benefits of Article 10?

Reasons: Wording of the provision.

Position: 1) No 2) Yes.

June 16, 2020

Laurie Wills Jack Chang
Abusive Tax Avoidance and Technical Income Tax Rulings Directorate
Support Division (416) 954-5164

2019-079265

Paragraph 10(8) of the Canada/UK treaty

This is in response to your request regarding a corporation resident in the United Kingdom (“UK Corporation”) that had control of less than 10% of the total votes of a corporation resident in Canada (“Canadian Corporation”) such that dividends on such shares would have been subject to a withholding rate of 15% under paragraph (2)(b) of Article 10 of the Treaty (footnote 1) .

However, the day before a dividend was paid, UK Corporation undertook transactions to ensure that it owned shares giving control of 10% of the total votes of Canadian Corporation and claimed the benefit of paragraph (2)(a) of Article 10 of the Treaty, providing for a withholding rate of 5% on that dividend.

You asked us to comment on the following questions:

1) Is the application of paragraph (8) of Article 10 of the Treaty conditional on a lack of connection of the ultimate dividend recipient with Canada (treaty shopping)?

2) Would its application result in UK Corporation being subject to a withholding rate of 25% under Part XIII of the Income Tax Act (the “Act”) on the basis that any benefits under Article 10 of the Treaty would be denied or would the dividend only be subject to a 15% withholding rate under paragraph (2)(b) of Article 10 of the Treaty on the basis that only the rate reduction in paragraph (a) would be denied?

Evolution of paragraph 8 of Article 10 of the Treaty

We did not find any document where the Income Tax Rulings Directorate (“ITRD”) would have addressed any matters dealing with paragraph (8) of Article 10 of the Treaty or other similar provision such as that found in paragraph 6 of Article 10 of the treaties concluded by Canada with Oman and Poland, paragraph 7 of Article 10 of the treaties that Canada has entered into with Taiwan, Hong Kong, Peru and Mexico, paragraph 9 of article 10 of the Canada-New Zealand treaty and paragraph 1 of Article 26 of the Canada-Columbia Tax Treaty. The former version of paragraph 8 of Article 10 of the Treaty was paragraph 7 of that article, which was in the Treaty when it was first signed in 1978 and remained in paragraph 7 until 2003.

That initial version of paragraph 7 of Article 10 read:

“If a resident of Canada does not bear Canadian tax on dividends derived from a company which is a resident of the United Kingdom and owns 10 per cent or more of the class of shares in respect of which the dividends are paid, then neither paragraph 2 nor 3 shall apply to the dividends to the extent that they can have been paid only out of profits which the company paying the dividends earned or other income which it received in a period ending twelve months or more before the relevant date. For the purposes of this paragraph the term "relevant date" means the date on which the beneficial owner of the dividends became the owner of 10 per cent or more of the class of shares referred to above.

Provided that this paragraph shall not apply if the shares were acquired for bona fide commercial reasons and not primarily for the purpose of securing the benefit of this Article”.

The paragraph was modified in the 2003 Protocol to the Treaty to become the current version, which reads:

“The provisions of this Article shall not apply if it was the main purpose or one of the main purposes of any person concerned with the creation or assignment of the shares or other rights in respect of which the dividend is paid to take advantage of this Article by means of that creation or assignment.”

On the face of the provision, our understanding is that the intended application of the initial version of paragraph 7 of Article 10 the Treaty was to deny withholding rate reduction on dividends paid by a corporation resident in the United Kingdom where the dividend was paid out of income earned in a period ending twelve months (or more) preceding the moment when the recipient’s shareholding reached 10% where such income was not taxed in Canada, both conditions having to be met.

The way the provision initially read suggests that the negotiators did not draft the provision to address abuses involving insufficient connection of the corporation paying the dividend or the shareholder claiming the benefit of paragraph 2 of Article 10 with their respective countries of residence but rather to deal with situations where a shareholder owns enough shares to have access to the 5% withholding rate under paragraph (2)(a) of Article 10 of the Treaty. In general terms, the initial provision called for maintaining the benefit of a 5% withholding rate on the distribution of income earned in the 12 months preceding the time of acquisition of enough shares to have access to such rate, where the shares were not acquired primarily to secure such benefit but rather for bona fide commercial reasons.

The 2003 change to then paragraph 7 of Article 10 of the Treaty broadened the scope of application of the provision to all circumstances where the main purpose or one of the main purposes of the creation or assignment of the shares is to take advantage of Article 10. It is important to note that the nature of the purpose test was converted from being an exception to the original anti-avoidance rule to being the anti-avoidance rule.

Context of paragraph 8 of Article 10 of the Treaty

From a Canadian perspective, the Act contains various anti-abuse provisions dealing with the acquisition of shares to obtain a tax benefit. These provisions include subsections 55(4), 83(2.1), 95(6) and 129(1.2). Although these provisions are not applicable here, they are examples of other provisions that deny a tax benefit under the Act where the benefit is conditional on a level of shareholding.

The language of paragraph 8 of Article 10 of the Treaty suggests that the intention of both Canada and the UK would have been that paragraph 8 of Article 10 of the Treaty not be limited to situations where the degree of connection of the ultimate dividend recipient with Canada is questioned.

Effect of the application of paragraph 8 of Article 10 of the Treaty

Paragraph 8 of Article 10 of the Treaty states that “the provisions of this Article shall not apply” where the conditions of application of paragraph 8 are met. Based on the plain meaning of this text, it is clear that no other paragraph of Article 10 of the Treaty would apply where paragraph 8 of Article 10 of the Treaty applies.

As noted in your request, paragraph 17 of the 2014 commentary of the OECD Model Convention (the “Commentary”) in respect of Article 10 of the OECD Model Convention (the “Convention”) indicates that the benefit in paragraph 2(a) of Article 10 of the Convention should not be granted in cases of abuse and proposes the addition of language to paragraph 2(a) of Article 10 of the Convention such as: “provided that this holding was not acquired primarily for the purpose of taking advantage of this provision”. In this regard, the proposed language was intended to specifically deny only the benefit provided in paragraph 2(a) of Article 10 of the Convention.

Contrary to paragraph 17 of the Commentary to Article 10 of the Convention, paragraph 21.4 of the Commentary to Article 1 of the Convention does not limit itself to denying the particular benefit under paragraph 2(a) of Article 10 of the Convention. Paragraph 21.4 of the Commentary to Article 1 of the Convention indicated that contracting states might want to include a broader provision to address potential abuse of Article 10 of the Convention more broadly: “the following provision has the effect of denying the benefits of specific Articles of the convention that restrict source taxation where transactions have been entered into for the main purpose of obtaining these benefits…. The Articles concerned are 10, 11, 12 and 21”. The proposed wording in that paragraph read: “The provisions of this Article shall not apply if it was the main purpose or one of the main purposes of any person concerned with the creation or assignment of the [Article 10: “shares or other rights”; Article 11: “debt-claim”; Articles 12 and 21: “rights”] in respect of which the [Article 10: “dividend”; Article 11: “interest”; Articles 12 “royalties” and Article 21: “income”] is paid to take advantage of this Article by means of that creation or assignment”.

The wording of paragraph 8 of Article 10 of the Treaty is in line with the wording suggested by paragraph 21.4 of the Commentary and not with the wording suggested by paragraph 17 of the Commentary. The fact that the 2014 Commentary proposes both alternatives confirms that either option would be acceptable and is consistent with the proposition that the negotiators intended that paragraph 8 of Article 10 of the Treaty would apply to deny the benefit of any benefit under Article 10 of the Treaty and not only to the benefit in paragraph 2(a) of Article 10 of the Treaty.

Consideration was given to whether paragraph 8 of Article 10 of the Treaty could apply only to dividends paid on a particular tranche of shares (ie. the initial acquisition of shares or a subsequent acquisition of shares resulting in 10% beneficial ownership, either directly or indirectly). We are of the view that would not be supported by the language of the provision as the determination of whether it is paragraph 2(a) or 2(b) of Article 10 of the Treaty that applies to a dividend is conditional on the percentage of votes controlled directly or indirectly by the beneficial owner of the dividend and paragraph 8 of that Article denies the benefit of the applicable paragraph. Moreover, in this regard, the absence of any “relieving” language appears to clarify that such an approach was not intended.

As such, in light of the text, context and purpose of paragraph 8 of Article 10, its application would result in the reduced withholding rates of 5% and 15% under paragraphs 2(a) or 2(b) of Article 10 of the Treaty being denied.

In summary, to answer your questions:

1) Is the application of paragraph (8) of Article 10 of the Treaty conditional on a lack of connection of the ultimate dividend recipient with Canada (treaty shopping)?

No.

2) Would its application result in UK Corporation being subject to a withholding rate of 25% under Part XIII of the Act on the basis that any benefits under Article 10 of the Treaty would be denied or would the dividend only be subject to a 15% withholding rate under paragraph (2)(b) of Article 10 of the Treaty on the basis that only the rate reduction in paragraph (a) would be denied?

UK Corporation would be subject to a withholding rate of 25%.

We trust that the above comments are helpful.

Yves Moreno
Manager, International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 In this letter, Treaty refers to the Convention Between the Government of Canada and the Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital Gains.